Thursday, September 30, 2010

German unemployment dropped by a non-seasonally adjusted 156,800 in September. Officially, 3.031 million Germans are unemployed. This is the lowest level since November 2008. In seasonally-adjusted terms, unemployment dropped by 40,000, pushing the seasonally-adjusted unemployment rate further down to 7.5%, from 7.6% in August.

On time for the 20th anniversary of German reunification, the German labour market has become a real success story. This has not always been the case. The reunification shock, a rigid labour market and slack in the economy had sent unemployment rates to double-digit levels for many years. The drop in unemployment from 12% in 2005 to the current level should be a good lesson for other countries, showing that structural reforms can yield positive results. But a lot of stamina is required.

Looking ahead, today’s labour market report bodes well for private consumption. Dropping unemployment numbers should bring psychological support for consumers, increasing the feel-good-factor. Even more important for private consumption, employment has been increasing since the beginning of the year and this trend should continue. Employment expectations are close to historical highs and the official vacancy index, BA-X, has returned to its pre-crisis level.

The German labour market has defied many sceptics and it is hard to find reasons why the current trend on the labour market should not continue. Even the reduction of the short-time work schemes does not affect the positive trend. With the current tail wind, it should not take long before unemployment will drop below the psychological threshold of 3 million. The good-news-show will continue.

Wednesday, September 29, 2010

The European Commission today presented its proposals to beef up fiscal surveillance in Europe. As expected, the proposals hinge on three pillars: a prominent role on debt, stricter sanctions and a new focus on competitiveness, trying to improve both the preventive and the corrective arm of the current Stability and Growth Pact.

As regards the preventive part, annual expenditure growth should not exceed medium-term GDP growth anymore. Countries not sticking to this rule could be penalised with a fine of 0.2% of GDP. Decisions on this fine should be taken with a “reverse voting” mechanism. This means that a sanction will be automatic but could be turned down by the Council (European governments). In the current setting, the Council always has to approve verdicts from the Commission.

As regards the corrective arm, more focus should be given to debt. The Commission proposes to make sanctions possible against countries where government debt exceeds 60% of GDP and where at the same time the debt ratio is not improving over a three-year period. The Stability and Growth Pact already foresaw the option of an “excessive debt procedure” but this procedure had never been made operational. In addition, sanctions should not come at the end of the ride as it is the case in the current setting but immediately when an excessive deficit or debt procedure is started. Again, the procedure of “reverse voting” should be applied.

Finally, the Commission came also up with a framework to tackle macroeconomic balances. Parallel to the procedure on deficits and debt, a new excessive imbalance procedure should be introduced. Based on a set of indicators, the Commission and the Council should identify imbalances and address them, eventually even with sanctions.All in all, the Commission’s proposals are a bold and balanced step towards a better fiscal framework. Not all proposals will see the light of legal action or will get watered down in some horse trading with national governments. In particular the excessive imbalance procedure rather looks like an intellectual hobby horse but will be hard to implement. Moreover, whether sanctions of 0.2% of GDP really scare off governments from running deficits is rather unlikely. (Temporarily) taking away voting rights would probably have a bigger impact. On a more positive note, the focus on debt will be essential in avoiding a second sovereign debt crisis in the future. Moreover, the idea of reverse voting is charming as it cleverly turns around the burden of proof.

With today’s proposals the Commission tries to take the lead in the debate, putting enormous pressure on the Council Working Group under Van Rompuy. The proposals underline the urgency and the fact that the window of opportunity to sharpen the current framework might me small. The Commission proposals are probably the best possible upgrade of the fiscal framework without entering a fiscal union. More is hardly possible. Now national governments have to react. It is now or never.

Wednesday, September 8, 2010

Industrial data shows that the high-flyer of the second quarter has been brought back down to earth, supporting the ECB’s cautiousness.

The third quarter has started on a negative note as the first batch of real economic data brought back a good dose of realism. Retail sales, new orders, and exports were all down and only industrial production showed some meagre growth. However, there is no need to panic. The industrial recovery is not over. But it will continue at a slower pace.

German industrial production only grew by 0.1% MoM in July. This was already the second consecutive month with disappointing industrial numbers. However, this pause of the upswing should remain temporary. Leading indicators, richly filled order books, the drop in short-work schemes and anecdotal evidence of labour shortages all point towards a renewed pick-up in industrial production in the coming months.

Exports also took the expected break after an impressive surge in the second quarter, dropping by 1.5% MoM. As imports at the same dropped by 2.2%, the trade surplus still improved. Looking ahead, German exports will have to deal with two downward risks: slower global demand and fiscal consolidation in other Eurozone countries. While these risks are for real, we do not expect them to choke off the export recovery. First of all, demand from emerging Asia and, in particular, China should remain stable and even demand from other industrialised countries should not entirely be dismissed. Secondly, German manufacturers could also benefit from a possible next investment initiative in the US. Finally, the impact of fiscal consolidation in the Eurozone on German exports should be marginal. The share of the Eurozone periphery countries in total German exports is still small. In the first half of this year, exports to Spain, Portugal, Greece and Ireland only totalled slightly more than 5% of total German exports.

Latest German data were a harsh reminder of the inevitable growth slowdown in the second half of the year. The slowdown of industrial activity also shows that a transition towards more self-sustained growth is not only desirable but really necessary. As long as even the recovery in the Eurozone’s showcase economy is not on solid footing, the ECB has no reason at all to change its current cautiousness.

Thursday, September 2, 2010

Despite upward revisions to the growth forecasts, ECB president Trichet tried to strike a cautious note in today’s meeting. As expected, rates remained on hold. As also expected, with thanks to Bundesbank president Weber, the ECB today announced an extension of its liquidity measures with full allotment until early next year. As a consequence, liquidity provision will remain ample, a next exit attempt will at the earliest only start in the first quarter of next year and rate hikes are still a distant future.

As regards the ECB’s assessment of the economy, ECB president Trichet tried to send a two-sided message. On the one side, the ECB sees a “positive underlying momentum” in the Eurozone economy since the recovery started and the ECB’s staff projections were significantly revised upwards. For 2010, the ECB now expects GDP growth of 1.6%, from 1.0% in June. For 2011, GDP growth is now expected at 1.4%, from 1.2%. On the other side, Trichet stressed prevailing uncertainty and even cautioned against too much optimism. In the Governing Council’s view, risks to the latest staff projections were slightly tilted to the downside.

As regards inflation, Trichet reiterated the almost traditional distinction between headline inflation and domestic price pressures. While strong global growth and energy prices could still lead to higher headline inflation, the ECB expects domestic price pressure to remain low. In the latest ECB staff projections, headline inflation is expected to come in at 1.6% in 2010, from 1.5% in June, and at 1.7% in 2011, from 1.6%.

While the ECB’s macro assessment did not bring any surprises and can be summarised as “a gradual sub-potential recovery without risks to price stability”, the ECB presented the official postponement of its liquidity exit. As expected, the ECB will provide unlimited liquidity until the first quarter of 2011. One-week and one-month refinancing operations will be offered at full allotment at least until 18 January 2011. Full allotment will also be applied to the monthly 3-month LTROs until the end of the year. Last but not least, the ECB will also carry out three fine-tuning operations on 30 September, 11 November and 23 December to smoothen out the expiring 6-month and 12-month refinancing operations. These measures are too big to only tackle the end-of-the-year problem for banks. They show that, despite the positive stress tests in July, the ECB is still concerned about the health of the financial system.

All in all, after Axel Weber’s comments almost two weeks ago, today’s meeting was almost predetermined to become a damp squib. Even the extension of the liquidity measures did not come as a surprise anymore. Today’s meeting and particularly the decision on the liquidity programme shows that the ECB still does not trust the recovery and the health of the financial system. The attempt to enter the exit lane has once again been postponed.

Thursday, August 26, 2010

While many market participants are currently debating the chances of a double dip and a global slowdown, German businesses are still gaining confidence. In August, the headline Ifo index increased to 106.7, from 106.2 in July; its highest level since June 2007. The current assessment continued its recent upward trend and increased to 108.2, from 106.8. At the same time, the expectations component dropped slightly to 105.2, from 105.5, but remains far above its historical average.

After impressive second quarter growth, it does not need a rocket scientist to come up with a 2010 growth forecast of around 3% for the German economy. At present, such a forecast seems to be rather cautious. Even if the economy was to stagnate in the second half of the year, GDP growth would already amount to 2.8% over the entire year. And stagnation does not seem likely. On the contrary, order books are still filling and there is anecdotal evidence of increasing backlogs and labour bottlenecks. Call this a luxury problem. Any future slowdown in global trade would take a while before it actually hit German industrial production. For the time being and for rest of the year, just processing the received orders could be enough to bring annual GDP growth to levels hardly seen since reunification.

Today’s Ifo index reflects untarnished confidence and bodes very well for near-term growth prospects. It might not be a new German “Wirtschaftswunder”, yet, and second quarter growth will remain exceptional. However, even with an inevitable shift into a lower gear in the second half of the year, the Eurozone’s growth engine will continue to run smoothly.

Friday, August 13, 2010

According to a first Eurostat estimate, real GDP in the Eurozone increased by 1.0%QoQ in Q2 2010, from 0.2% in Q1. This is the strongest growth rate since Q1 2008. No components are available yet, but exports, investments and a catching up of the construction sector after a harsh winter should have been the main growth drivers.

Turning to the available country data, the recovery has gained traction in almost all Eurozone countries. Only Greece still experienced a sharp growth decline with a drop of 1.5% QoQ. All other countries have left recession, with Spain (0.2% QoQ) and Portugal (0.2% QoQ) still lagging behind. Core Eurozone countries were the best growth performers in the second quarter, led by Germany (2.2%), the Netherlands (0.9%), Austria (0.9%), Belgium (0.7%) and France (0.6%).

Today’s numbers are a clear sign that the Eurozone has coped with the sovereign debt crisis better than expected. Of course, the Eurozone growth story is still pretty much a German export story. Although several other core Eurozone countries also showed promising developments, it is too early to become overly enthusiastic. In particular, the Southern Eurozone countries are not yet out of the woods. Fiscal consolidation and structural reforms will first weigh on growth before they can become growth-supporting.

After three difficult months of Eurozone battering, today’s numbers will help to heal the Eurozone’s wounds. For the first time since Q2 2009, the Eurozone outpaced the US economy. However, one should not get carried away by emerging decoupling dreams. The last 40 years have shown that Eurozone decoupling from the US economy has always been an illusion. At best, only the Eurozone’s current main attraction, the German economy, has the potential to start a period of growth outperformance.

Today’s first estimate of German GDP growth in the second quarter confirmed an excellent growth performance. According to the first estimate by the German agency for statistics, the German economy grew by an impressive 2.2% QoQ in Q2 2010. This is the strongest quarterly reading since German reunification. Compared with Q2 2009, German GDP increased by 3.7%. The decomposition of the GDP numbers will only be published in two weeks but recent monthly data indicate that growth was driven by exports and investments, while the drop in private consumption should at least have come to an end. In addition, the numbers for the first quarter of 2010 were revised upwards to 0.5% QoQ, from 0.2%.

The strong Q2 performance of the German economy is impressive but not surprising. Structurally in a much better shape than many other industrialized countries, it was just a matter of time before the German economy would pick up further speed. In the second quarter, the German economy mainly benefitted from two factors: a catching up in the construction sector after the harsh winter and strong foreign demand for German goods.

Looking ahead, it is almost needless to say that the current growth momentum is hardly sustainable in the coming months. With the one-off impact from the construction sector and normalizing of export growth, German growth will return to more ordinary growth numbers. Nevertheless, despite an inevitable slowdown, all ingredients are there for the German economy to take the next step towards a self-sustained recovery. Confidence indicators are still at high levels, order books are amply filled and German job miracle is continuing. With more and more people returning from short-work schemes to full time schemes to work off increasing backlogs, some minor employment growth should not be excluded, further improving private consumption.

Today’s numbers are an impressive reminder that the German economy is currently playing in a league of its own. However, watch out not to get carried away by blind cheer. As much as the Q1 GDP numbers underestimated the real strength of the economy are Q2 numbers now overestimating it. As so often, the truth lies somewhere in-between. With some slowing down in the coming quarters, the German economy will rejoin the league of the other Eurozone countries. Nevertheless, the German economy should remain the top attraction of the Eurozone league for some time.

Monday, August 9, 2010

German exports increased by 3.8% QoQ in June, from a May surge of 7.9%. At the same time, imports increased by 1.9%, from 13.7% in May. As a consequence, the trade surplus widened further to 14.1 billion euro, from 9.8 billion euro in May, supporting the strong pick-up in economic growth in the second quarter.

The German export sector remains the main driver of the recovery. Needless to say that the current export dynamics are not a new status quo. They will eventually slow down. However, with still strong demand, particularly from Asia, for goods “Made in Germany” and the lagging impact of the euro weakening in the first half of the year, German manufacturers are looking into a bright near term future. Filled order books speak volumes. As a consequence, further improvements in the manufacturing sector should once again stabilize the labour market. With more and more people returning from short-work schemes to full time schemes to work off increasing backlogs, some minor employment growth should not be excluded in the coming months.

With today's trade numbers, the time of nitpicking has come to an end. This week’s release of second quarter growth should be a cracker. Up to now, industrial production has shown an impressive performance and even private consumption seems to have stabilized. The German economy is bound to see its strongest quarterly growth rate since reunification.

Thursday, July 8, 2010

Spring sprint accelerates. German industrial production increased by 2.6% MoM in May, from 1.2% in April. The increase was driven by the production of intermediate (3.2% MoM) and capital (4.6% MoM) goods. The production of consumer goods increased by 1.7%, while the construction sector showed a first correction after two strong months. Earlier today, German exports had already surged by 9.2% MoM in May, from a 6.3% drop in April.

It is obvious: the industry remains the backbone of the German economy. Even if industrial production was to stagnate in June, it would still have grown by around 5% QoQ. With today’s numbers, an excellent second quarter has further materialised. Fasten your seat belts.

Looking ahead, filling orders books and business expectations back at pre-crisis levels bode well for the second half of the year. Even if the current strong momentum will be hard to sustain. The ongoing investment-led global recovery should support the German export sector in the coming months. In addition to the demand component, the price component is also supporting German exports. German exporters remain one of the biggest beneficiaries of the weaker euro. Since October last year, the real effective exchange rate dropped by 7%. Only the Netherlands and Ireland saw a stronger improvement of their international cost competitiveness positions.

While German consumer confidence probably took a hit yesterday evening and a World champion title is out of reach, the German economy is still a promising candidate in another race: the one of Eurozone growth champion 2010.

Tuesday, June 22, 2010

German businesses defied sovereign debt worries as the Ifo index rebounded in June. The headline index increased to 101.8, from 101.5; its highest level since May 2008. The current assessment continued its recent upward trend and increased to 101.1, from 99.4. At the same time, the expectations component dropped for the second consecutive month, decreasing to 102.4, from 103.7.

Right now, the only worry of the German economy should be sluggish domestic demand. The export engine is humming and should make the second quarter a real smash. For the time being, the inventory cycle, strong global demand and the weak euro will continue to support the export-led recovery. Some unexpected support for the German economy could now come from the Far East. The Chinese announcement to allow for a more flexible currency - if implemented - would benefit German exports. China has significantly gained importance as an export destination. Over the last year, German exports to China have increased by almost 70%.

Today’s Ifo reading shows that grass-rooted German businesses seem to be looking through the sovereign debt worries and recent market turmoil. They keep it simple and look at the upshots of the current crisis: the weaker euro. Of course, the current growth dynamics will slow down eventually. However, for the time being, the German export engine is running smoothly, making Germany the economic powerhouse of the Eurozone.

Friday, June 11, 2010

After months and months of exciting and surprising ECB press conferences, today’s meeting brought some welcome boredom. As expected, the ECB kept interest rates unchanged at today’s meeting. The most important announcement came on the ECB’s liquidity provision: the ECB decided to return its 3-months LTROs to crisis mode of full allotment and fixed rates until the end of September.

The ECB’s assessment of the economy and the inflation outlook were almost a verbatim copy of the May assessment. The recovery remains on track and the ECB has become more positive on the first half of the year. However, president Trichet continued to stress unusually high uncertainty. Turning to inflation, President Trichet reiterated last month’s distinction between headline inflation and domestic price pressures. While strong global growth and energy prices could still lead to higher headline inflation, the ECB expects domestic price pressure to remain low.

This cautiously positive outlook was confirmed by the latest ECB staff projections. For 2010, both the growth and inflation outlook were slightly revised upwards from the March forecasts. For 2011, growth expectations have been lowered. In detail, ECB staff expects GDP growth to come in at 1.0% in 2010 and 1.2% in 2011 (from 0.8% and 1.5%). As regards inflation, ECB staff now expects headline inflation at 1.5% in 2010 (from 1.2%) and 1.6% (from 1.5%) in 2011. Inflationary pressure looks different. It did not come as a surprise that the current level of interest rates remains “appropriate” – a clear hint of the ECB’s intent to keep rates on hold in the near term.

As expected, most questions at today’s press conference were on the ECB’s de facto quantitative easing and the clumsy communication around it. Trichet repeated earlier comments and speeches, stressing that the bond purchase programme was necessary to ensure an effective functioning of monetary transmission in all market segments. He did not give any additional details on the planned total amount of the programme or the regional focus. To ensure that certain Bundesbankers do not get overcome with fear of hyperinflation, Trichet emphasised the ECB’s determination to maintain price stability. The ECB remains “inflexibly attached to price stability”.

Trichet also stressed the sterilisation of the bond purchases. However, it is rather a pseudo sterilisation if banks can still get abundant liquidity at the ECB. And this will not change soon. Today, the ECB announced it would extend the 3-month LTROs with full allotment and fixed rates until the end of September. Possible liquidity needs stemming from the maturing one-year LTRO at the end of June will be smoothed. Moreover, the high level of deposits at the ECB does not only reflect increased money market tensions but should also work as a buffer. In fact, this implies that ample liquidity will remain in the interbank market until the end of the year.

To sum up, the ECB has again moved into a wait-and-see position. The ECB confirmed its inflation-fighting spirit, while at the same time providing ample liquidity at least until the end of the year. After several u-turns, clumsy communication and sharp criticism, the ECB today tried to recover its old poise. President Trichet was back in shape, being masterly reticent.

Tuesday, June 1, 2010

German unemployment decreased by a non-seasonally adjusted 164,800 in May. Officially, 3.242 million Germans are currently unemployed. This is the lowest level since November 2009. In seasonally-adjusted terms, unemployment dropped by 45,000, pushing the seasonally-adjusted unemployment rate to 7.7%, from 7.8% in April. This is the lowest unemployment rate since December 2008 and illustrates the strong Spring revival of the German labour market.

The bogey of mass unemployment has been shooed away. Successful labour market reforms, the government’s famous crisis tool of short-work schemes and companies’ prudence have made the labour market the bright spot of the recession. Even better, the labour market seems to turn much earlier than many had thought. Leading indicators, historical evidence and latest promising recruitment plans all suggest that the current positive trend on the German labour market will continue in the coming months. It should only be a matter of a few months before the unemployment rate returns to its pre-crisis level.

Despite the labour market’s success story, policy complacency would be misplaced. The positive trend of recent months should be used to unwind the labour market crisis measures and to return to active employment growth policies. In this context, the recent decision from the German government to extend the famous short-work schemes once again until March 2012 was the easiest but probably also most dangerous solution. It only postpones but does not solve the exit problem.

Thursday, May 20, 2010

The German ban of naked short-selling has caused new uncertainty in financial markets. It also met a lack of understanding from other Eurozone countries. The German solo attempt is a risky game.

What is good for Germany, is good for Europe. Since the start of the financial crisis, this very often seems to have been the guiding theme of the German government. However, remember the u-turns on bank guarantee schemes, economic stimulus packages and the approach to the Greek crisis? Initially against a coordinated European action, the German government often changed its mind, implemented national policies and confronted the rest of the Eurozone with a fait accompli. In the end, this strategy still led to good results but also to a lack of understanding from other Eurozone countries. Tuesday night’s decision to ban naked short selling seems to fit into this German strategy.

The German Ministry of Finance banned naked short-selling of sovereign bonds, CDS related to risks outside the Eurozone and the stocks of ten German financials. German Chancellor Merkel announced that the ban would remain in place until a common European solution has been found.

It still remains unclear what triggered this overnight decision. Did the German government have insider information which made the immediate ban indispensable? Was the German government dissatisfied with the European approach to tackle speculation and did it want to push other countries to do the same by presenting an accomplished fact? Or was it simply driven by domestic politics and the fading public support for the government? While all three explanations are plausible, the decision to ban naked short selling was in our view mainly driven by domestic politics. This view is supported by the fact that on Tuesday the German government also agreed on an international tax on financial markets. Details of this tax are still unknown and the ultimate success of such an international financial tax is also uncertain. However, it illustrates the government’s willingness to fight speculation, a policy topic which should find positive feed-back in the German public. Moreover, it undermines the German opposition’s attempts to gain political ground by proposing a financial transaction tax.

According to German Chancellor Merkel and Finance Minister Schäuble, the decision was needed to further stabilise financial markets. Recent measures had not been sufficient. Yesterday’s reactions in financial markets and comments from other Eurozone countries, however, showed that this goal had not been achieved. Markets dropped significantly and several Eurozone countries reacted with incomprehension. On substance, the German decision was welcomed. However, the timing and the solo attempt was less appreciated. Up to now, the German decision has left more uncertainties than clear facts. While the German government had somewhat slowed down the finalising of the €440bn Special Purpose Vehicle during the Eurogroup meeting on Monday, it now jumped the gun on financial market regulation. A clear line now looks different.

In the first stages of the current crisis, the Eurozone was affected by a global crisis. In these first stages, Germany’s more domestically oriented approach might not have been to the liking of everyone but it still delivered reasonable results. At the current juncture, however, the Eurozone is in the middle of a homemade sovereign crisis. In this situation, a coordinated European approach with a clear and strong commitment of all countries seems to be the only way out. In this context, the German solo attempt is a risky game as it creates new uncertainty in a just stabilising situation. To further stabilise financial markets, a clear line and commitment on the Special Purpose Vehicle and strong proposals for a new fiscal framework in the Eurozone might have been a better option than banning naked short selling.

Tuesday, May 18, 2010

The German ZEW index dropped in May on the back of recent market turmoil. The ZEW index which measures investors’ confidence now stands at 45.8, from 53 in April; still clearly above its historical average. At the same time, investors have again become more positive on the current economic situation. The current assessment component increased for the twelfth consecutive month to its highest level since September 2008.

Today’s ZEW index illustrates the uncertainty the current sovereign debt crisis and latest market turmoil have created. The harsh winter, volcanic ashes, the Greek crisis, high market volatility and now the country’s most famous ankle, many unexpected events have challenged the robustness of the German recovery. However, up to now, the fundamentals of the Germany economy have rather improved than worsened. First quarter growth was better than initially feared, order books are filling and all leading indicators point to a further growth acceleration in the second quarter.

Looking beyond the summer, the growth momentum should slow down somewhat. Fiscal consolidation will also weigh on the German economy. Tax cuts have now officially been shelved at least until 2012. Additional consolidation efforts are also likely as the German government will want to continue its policy of leading by example. However, there is at least one upshot from the current crisis: the weaker euro. While many observers currently tend to see the euro as a crisis barometer, recent surveys show that many German businesses tend to be more pragmatic. For them, the weaker euro could be a blessing which simply boosts exports.

Wednesday, May 12, 2010

According to the first estimate by the German agency for statistics, the recovery continued in the Q1 2010. The German economy grew by 0.2% QoQ. Compared with the Q1 2009, German GDP increased by 1.7%. The decomposition of the GDP numbers will only be published in two weeks but recent monthly data indicate that growth was driven by exports and investments, while private consumption remained a drag on growth. In addition, the numbers for the fourth quarter of 2009 were revised upwards. Instead of stagnating, the German economy also grew by 0.2% QoQ in Q4 2009.

The strong March figures came right in time to make an almost lost quarter look somewhat better. Looking ahead, the recent Spring revival bodes well for the second quarter. All indicators signal a strong rebound. Confidence indicators are back at their pre-crisis levels, order books are still growing, the labour market is further stabilising and parts of the government’s stimulus package are only currently finding their way into the economy.

If Sunday’s big bail-out package succeeds in calming markets and confidence, the short-term impact from the Eurozone’s fiscal crisis on the German economy should be limited and even positive. Lower bond yields and the weaker euro could benefit the German economy. However, fiscal consolidation in several Eurozone countries and ending stimulus packages should have a downward impact on growth in the second half of the year.

Today’s numbers show that the recovery is continuing, even with the harsh winter weather. Still, the numbers do not show the recovery’s true colours, neither will second quarter growth. The bumpy ride will continue and, at least in the coming months, it should be a nice ride.

European policymakers have put a loaded bazooka on the table. In a co-ordinated action, Eurozone governments and the IMF have decided to provide around €750bn for Eurozone countries with weak public finances. At the same time, the ECB has entered unchartered territory to prevent systemic risks.

Like all good plans, the Eurozone bail-out scheme is not without risk or uncertainties. Governments and parliaments still need to agree, borrowing conditions are still unclear and the ECB put its credibility at risk.The Eurozone’s bazooka will not solve fundamental fiscal problems, but it should prevent speculative contagion. Countries like Portugal and Spain have now some time to prove that they are different.

With the ECB buying government bonds, the risk of a systemic crisis should diminish. In a worst case scenario, the ECB could even make an orderly default possible.

The ECB’s credibility is now in the hands of governments, as the success or failure of the big bang still depends on the implementation of fiscal consolidation. There will come a time when the ECB will want to restore its credibility as an inflation fighter. However, for the time being deflationary risks from fiscal consolidation still prevail.

Friday, May 7, 2010

German industrial production increased significantly in March, more than offsetting the winter dip. Industrial production was up by 4.0% MoM, from -0.2% in February. The increase was mainly driven by the production of capital and intermediate goods, and above all by the construction sector. As expected, after the end of the winter, the construction sector bounced back impressively by 26.7%.

Today’s numbers clearly illustrate that the industry’s hibernation has ended. With today’s strong increase in industrial production numbers, chances have increased that next week’s first estimate of Q1 GDP growth could be slightly positive. Whether positive or negative, the first quarter was not a good reflection of the sound underlying recovery. It will take until the second quarter before the real strength of the recovery will be visible.

With filling order books, business expectations back at pre-crisis level and increasing recruitment plans, the near term future for the German economy looks bright. However, the ongoing sovereign debt crisis will very likely also take its toll on the German economy. Therefore, it will be hard to take the current impressive momentum into the summer months. Enjoy it as long as it lasts.

Thursday, May 6, 2010

As widely expected, the ECB today decided to keep interest rates on hold. It is obvious that in the current rather deflationary environment, rate hikes are only a scenario for the far-off future. In the Q&A session, all questions were once again related to Greece. Trichet did nothing to evoke new speculation about possible ECB steps. To the contrary, in what could be seen as an attempt to escape the Greek crisis, the ECB has secretly become more hawkish.

For the first time in a long while, at least the text of the ECB’s economic assessment was changed. On substance, the main message is still the same: the recovery of the Eurozone economy is continuing. However, there were some interesting changes to the ECB’s take on inflation.

According to the ECB, real GDP is expected to expand at a moderate pace and risks remain balanced. Greatest downward risks stem from the financial crisis, balance sheet adjustments and the labour market. As regards inflation, the ECB introduced a new distinction between global and domestic inflationary pressures. While global inflationary pressures might increase due to energy prices and emerging market inflation, domestic inflation in the Eurozone is expected to remain contained. Inflation expectations remain firmly anchored but the risks are only “still” remaining broadly balanced. In addition, two important sentences have been added to the ECB’s introductory statement: “The firm anchoring of inflation expectations remains of the essence. Monetary policy will do all that is necessary to maintain price stability in the euro area over the medium term”. In normal times, this would have marked a turning point towards a more hawkish stance. However, these are no normal times.

As expected, the Q&A session was only about Greece. Prior to the meeting, there had been plenty of market rumours and advice about the ECB could or should do in reaction to the Greek crisis. Several observers even proposed to ultimately purchase government bonds. Just looking at the facts, the ECB still owns the same toolbox as in the past. Theoretically, it could restart FX swap lines, renew one-year LTOs or extending full allotment procedures at its refinancing operations. A more radical move would be to purchase government bonds in the secondary market. However, such a step would be very controversial to say the least. In today’s press conference, Trichet did not give any hints that the ECB would soon be willing to go beyond last Sunday’s decision when they announced to accept Greek debt as collateral no matter what its rating is.

All in all, the ECB tried to say as little as possible on Greece and possible future action. Maybe this was the lesson from the last weeks and months when several u-turns and unfortunate communication had not done the ECB’s credibility any good. With significant deflationary pressure still looming from future fiscal consolidation, the ECB’s more hawkish tone was probably a bit exaggerated. However, it was an attempt to return focus back to what the ECB is best at: conducting monetary policy.

Thursday, April 29, 2010

German unemployment decreased by a non-seasonally adjusted 162,000 in April. Officially, 3.406 million Germans are currently unemployed. In seasonally-adjusted terms, unemployment dropped by 68,000, pushing the seasonally-adjusted unemployment rate to 7.8%, from 8.0% in March. This is the lowest unemployment rate since December 2008 and illustrates the strong Spring revival of the German labour market.

Statistical changes and active labour market policies, including the famous short-work schemes, made the labour market the bright spot of the recession. Moreover, the formerly very rigid German labour market has slowly but surely become more flexible. Even without official short-work schemes, social partners in most sectors can agree on a temporary reduction of the regular working week. The downside of this flexibility of course is that disposable incomes declined which explains why private consumption has not kept pace with the labour market.

Looking ahead, leading indicators, historical evidence and recent wage settlements with job guarantees all point to a further stabilisation of the labour market in the coming months. The positive trend should also be supported by the latest decision from the German government to extend short-work schemes once again until March 2012. However, as a continued stabilisation of the labour market should initially be marked by a pure unwinding of short-work schemes and increasing working hours, employment growth will be sluggish. Still, even if it is only a small boost, the labour market could end the private consumption recession of late-2009.

At least for the time being, the German good-news-show of the last weeks continues. The harsh winter, the Greek crisis, they have all left the German labour market unperturbed.

Friday, April 23, 2010

Up again. The German Ifo index surged again in April as current conditions improved significantly. The headline index increased to 101.6, from 98.2, and is now at its highest level since May 2008. The current assessment jumped to 99.3, from 94.5. At the same time, the expectations component continued its impressive upward trend of recent months, increasing to 104.0, from 102.0.

Today’s Ifo index adds further evidence that the pause of the German recovery around the turn of the year was nothing more than a temporary break. In terms of economic growth, the first quarter will have been another disappointment. Still, some moderate growth should not be excluded, yet. It only needs a marginal pick-up in industrial production and net exports in March to turn first quarter growth from slightly negative into positive territory.

Looking ahead, the underlying trend of the German recovery remains healthy: business confidence is high, order books are filling, recruitment plans are increasing and even investment prospects are improving. New car registrations in March were one illustration of the recovery gaining traction. The sharpest increase in three years was mainly driven by business vehicles, indicating that companies have started to invest into their truck and vehicle fleets.

All in all, market headlines of recent weeks had the potential for a severe depression. The Greek fiscal crisis, possible contagion of other Eurozone countries and the volcanic ashes: They all seem to threaten the recovery. However, German businesses seem to be untouched by these downbeat scenarios as most confidence indicators have returned to their pre-crisis levels. Maybe German businesses are too down-to-earth, just looking at their filling order books and ignoring dark clouds of fiscal consolidation. Nevertheless, if the real economy now follows up on confidence indicators’ promises, the near future looks very bright.

Friday, April 9, 2010

Of course, there was no news on interest rates. The ECB decided to keep interest rates unchanged at today’s meeting. The more interesting part of the ECB meeting was on the collateral framework and the ECB’s communication on Greece.

The ECB’s assessment of the economy and the inflation outlook remained virtually unchanged. Recent indicators have confirmed the ongoing, though shaky, recovery. The ECB still expects the Eurozone economy to grow at a moderate pace in 2010. The only very slight change in the ECB’s assessment came on inflation. Price developments are now expected to remain “moderate” in stead of “subdued” at the last meeting. Despite this little stylistic change, it does not take away the fact that deflation rather than inflation will remain the biggest concern of the ECB in months ahead.

As expected, the ECB announced some changes to its collateral framework. The current crisis threshold for marketable and non-marketable assets at investment-grade level will be continued beyond the end of 2010, except for asset-backed securities. In addition, the ECB will introduce a new graded haircut scheme in January 2011 and will no longer accept debt instruments denominated in other currencies. Haircuts will be gradually increasing and at least 5%. This new system will only be applied to assets rates in the BBB+ to BBB- range and it will replace the current haircut of 5%. More details will only be revealed in July. However, sovereign bonds will apparently not fall under this new haircut scheme. For government bonds falling under the A- threshold, the old 5% haircut would continue. After all the excitement, the actual changes to the collateral framework seem to be less bold than they could have been. Whether this is a missed chance, remains to be seen.

Most time of the press conference was dedicated to Greece. Prior to the Eurozone’s decision on Greece on 25 March, the ECB had been opposing an IMF involvement, sometimes even very outspokenly. Today, Trichet had a few weak moments and did not really succeed in convincingly explaining the ECB’s u-turn. The ECB’s official position now is that it welcomes the statement on Greece. According to Trichet, Eurozone governments had to take up their responsibility and so they did. The presented joint safety net together with the IMF was a workable statement. Interestingly, there still seems to be some differences of opinion regarding the interest rates at which eventual Eurozone loans should be given to the Greek government. Differences of opinion at least with the German government. Trichet agreed with the principle that loans should be given without subsidies and considered market rates at least the interest rates with which other Eurozone countries can get funding in the market. It is doubtful whether Ms. Merkel has the same understanding of market rates.

The ECB’s walk on Greek eggshells has definitely been nothing to write home about. Crystal-clear communication looks different. However, Trichet did everything not to add fuel to the fire. He even remarked that a Greek default “was not an issue”. Anyway, once the dust has settled, the real substantial issues should emerge again. As regards Greece, it will be the Eurozone governments which have to decide and not the ECB.

All in all, denial or not, Greece is keeping the ECB in wait-and-see mode at least until the end of the year. Fiscal tightening and structural adjustment will make deflation not inflation the major worry of the year.

German exports increased by 5.1% MoM in February, almost offsetting the sharp 6.5% drop in January. At the same time, imports only increased by 0.2% MoM, from 5.6% in January. As a consequence, the trade surplus widened to 12.1 billion euro, from 8.7 billion euro in January.

Today’s sharp increase in German exports was not, yet, enough to turn net exports into a growth driver in the first quarter but it clearly shows that the export-led recovery is still in tact.

Now that all monthly data for February has been published, it is time for a brief intermediate assessment of the German economy. Indeed, the month February had something for everyone; for the advocates of a German double-dip as well as for the camp of an ongoing recovery. With disappointing industrial production, stagnating new orders and weak private consumption, first quarter growth looked set to be flat, at best. Today’s exports open the door for upcoming surprises.

Nevertheless, it would be foolish to now advocate the end of the German recovery. First of all, the jury on the first quarter is still out. While February numbers have been strongly influenced by adverse weather conditions, it only needs a little positive surprise in March to return the German economy to a positive growth path. Secondly, the largest part of the government’s public investment programs still has to reach the economy. And finally, most leading indicators point Northwards. Order books are filling, business expectations are approaching historical highs and employment has grown actually grown in the first quarter. Positive growth surprises are still in the pipeline. Under the surface of the February snow blanket, something good is brewing.

Thursday, April 8, 2010

German industrial production remained on hold in February. What’s more disappointing is the downward revision of the January number to a meagre growth of 0.1% MoM, from initially 0.6% MoM. While the production of capital goods increased by 1.5% MoM, the production of consumer goods dropped by 2.3% MoM. At the same time, the construction sector was not, yet, able to shrug off the impact from the harsh winter, only increasing by 1%, from a 14.2% decline in February.

Today’s disappointing industrial production numbers have increased the likelihood of another weak quarter after the economy’s standstill in the fourth quarter.

Looking ahead, unless March has some real good surprises in the offing, strong growth will only return in the second quarter. However, there is hardly any reason to become pessimistic again. All ingredients for a catching up of the economy are there. The largest part of the government’s public investment programs still has to reach the economy. Moreover, order books are filling, business expectations are approaching historical highs and employment has grown actually grown in the first quarter. The first quarter weakness was temporary, not structural. It simply takes a while before the economy gets rid of the snow blanket.

Thursday, March 25, 2010

Is this now finally it? Yesterday night, Eurozone leaders cut the Gordian knot and came up with a long-awaited "blueprint" for how to deal with the Greek fiscal crisis. The Eurozone countries have presented a package, “involving substantial International Monetary Fund financing and a majority of European financing”. According to the statement Eurozone countries “are ready to contribute to coordinated bilateral loans”. Any financial aid must be an “ultima ratio” which means the aid will only be given if Greece cannot raise enough funds from the markets. According to the Eurozone statement, Eurozone countries would contribute bilateral loans in proportion to their shares in the capital key of the ECB. These loans would be given at market interest rates and not at an average Eurozone rate. The coordinated bilateral loans would have to be agreed unanimously by all Eurozone countries which actually means that Germany (or any other country) could still stop Eurozone aid.

With the now found solution, both France and Germany could limit damage to their public image. The German government could push through its demand to bring the IMF on board, while France can still emphasise the European character of any future aid package to Greece. The two biggest losers of the last days are the European Commission and the ECB which until the very last moment objected against bringing the IMF on board.

Looking ahead, the jury is still out whether the Eurozone's statement will benefit or harm the Eurozone. While some market participants could see the IMF involvement as evidence of incapacity, the long-term impact could be better than some might think. Now the Eurozone has a credible instrument to temporarily bypass the constructional flaws of the European Treaty. The now presented toolbox is probably a better precedent for future cases than any other ad hoc solution. However, it is also obvious that the Eurozone needs to polish up its fiscal framework quickly. Better prevention and a functioning crisis resolution mechanism have become indispensable.

As so often in European decision-making, the way to a solution was messy. However, in the end it is only the results that count. Once the dust has settled, yesterday’s blueprint could prove to be the best solution. Essentially, yesterday's agreement confirms that the Eurozone will not let Greece go down without opening the door for possible future free riders. European solidarity still exits but it does not come for free. Neither for the givers, nor for the takers of this solidarity.

Just a few hours ahead of the long-awaited EU summit, Greece received some unexpected relief. During his appearance at the European Parliament, ECB president Jean-Claude Trichet announced that the ECB will keep the minimum credit threshold in the collateral framework at investment grade level (BBB-) beyond the end of 2010. In parallel, the ECB plans to introduce, as of January 2011, a “graded haircut schedule”. As part of its non-standard measures during the financial crisis, the ECB had lowered the threshold for assets accepted as collaterals to triple-B-minus, from A-minus. While other non-standard measures are now gradually phased out, the crisis measure will stay.

Technical details of the plan will be presented at the press conference after the next ECB meeting on 8 April. At least two main questions will then have to be answered: will the new rules only apply to government bonds or to all other asset classes currently eligible as collateral? Will a threshold (minimum rating) still exist? At present it seems likely that different haircuts will be applied for every rating level going down to BBB-. The question is whether the graded haircut schedule would also apply for ratings below BBB-. Currently, the only haircuts the ECB applies to sovereign debt are tied to the maturity, not the credit rating.

A new “graded haircut schedule” could be seen as the ECB’s contribution to increase fiscal discipline in the future. As a consequence, yield spreads across the Eurozone could be wider than in the past.

Wednesday, March 24, 2010

Did anyone say double-dip? The German Ifo index surged to 98.1 in March, from 95.2 in February; its highest level since June 2008. The increase was driven by both the current assessment and the expectation component. The current assessment is clearly leaving its depressed levels, increasing to 94.4, from 89.8 in February. At the same time, the expectations component continued its strong upward trend and is now at its highest level since June 2007. Earlier today, the German PMI manufacturing surged to its highest level ever and the PMI services jumped to 23-months high.

Today’s confidence indicators show that the pause of the German recovery around the turn of the year was nothing more than a temporary break. The underlying trend of the German recovery remains healthy: business confidence is high, order books are filling, recruitment plans are increasing and even investment prospects are improving. The German “export machine” is gathering speed again.

There it is again: the German export machine. Together with the European and Greek fiscal crisis, the German export model has dominated headlines in recent days. However, it seems a bit short-sighted to blame German exports for the problems of other Eurozone countries. Very often, German exporters do not compete with other Eurozone exporters but with Chinese, American or Japanese exporters.

While the timing of the debate on the German export model might not have been productive in finding a Eurozone agreement on how to deal with the Greek fiscal crisis, the need for more German domestic demand is undisputable. The German economy needs more domestic investment and consumption. Not for the sake of other Eurozone countries but for the sake of transforming the current rebounce into a self-sustained boom. With the highest economic stimulus packages of all Eurozone countries and the tax relief agreed under the new government, it is hard to criticise Germany for inactivity. In a way, the current uncompromising German position on Greece could even benefit Eurozone rebalancing. Last week’s u-turn on Greece seems to be – partly – driven by the upcoming crucial regional elections in North Rhine-Westphalia. Losing these state elections would rob the government’s majority in the German upper house, limiting scope for major (tax) reforms.

A scary export machine to some, to others it is an export-driven recovery. In any case, today’s Ifo confirms that the German economy will leave its winter depression soon.

Thursday, March 4, 2010

While the one-needled compass would clearly allow the Governing Council to take a longer vacation break, the phasing out of the ECB’s liquidity measures is continuing. Which measures were today unwound? Firstly, the 6-month longer-term refinancing operation (LRO) of 31 March will be the last one of its kind and it will be conducted at a floating rate, like the December 12-month LRO. Secondly, as of the end of April, 3-month refinancing operations will return to their normal structure with a variable rate tender procedure. All other measures remain in place: one-week and one-month refinancing operations will continue to be conducted at fixed rates with full allotment, at least until 12 October 2010. As a consequence, excess liquidity through full allotment will remain in the markets at least until early November, enabling banks to rollover any needs from the expiring first two 12-month LROs.

Of course, besides the ECB’s exit strategy, Greece and the austerity measures presented yesterday were the dominant topics of the press conference. However, Trichet only reiterated the ECB’s official position which welcomed the convincing additional and permanent fiscal consolidation measures. According to Trichet, the measures were “a key signal both for the long-term fiscal sustainability and for substantially enhancing the price and cost competitiveness of the Greek economy”. Despite this moral support, Trichet refrained from further comments.

To sum up, the Greek roadblock on the exit strategy has become a speed bump. The phasing out continues but at a much slower pace. Generous liquidity provisions were effectively extended until November. By returning to variable rate tenders at the 3-month operations and keeping full allotment at the shorter maturity, the ECB is trying to gradually get its grip back on money market rates. If this strategy works, the ECB could theoretically start hiking rates before all liquidity measures end. However, this theory, reality is often different.